Industrial Organization: Contemporary Theory and Empirical Applications, 5th Edition

4

Technology and Cost

In late 2001, Microsoft introduced its first Xbox video game console. The relatively simple model for which only a few games were available sold at a retail price of $300. By 2004, the price had fallen to $150 despite technical improvements, as Microsoft prepared to launch the new Xbox 360 series. The base or Core model 360 emerged in 2005 at a price of $300—a price that fell to $200 in 2008 as the Core model was replaced by the Arcade series with initially a 60GB hard drive. That price fell further over the next two years, even as the hard drive capacity grew to 250GB and more features and games were added. As this text is going to press, an Xbox 360S series along with a Kinect scanner that allows full-body gaming is selling as a bundle for $250. In sum, the price of an Xbox game console has declined over the last decade—especially if the vastly improved technical features are considered—despite the fact that the prices of other consumer goods have risen over 25 percent (about 2.6 percent per year) in that same time period.

Clearly, Microsoft's pricing strategy reflects in part its rivalry with other video game platform producers such as Sony and Nintendo. Yet the above prices must also reflect Xbox production costs because the profitability of any price choice will depend critically on the cost of producing each unit of the total sold at that price. More generally, production costs affect both firm behavior and industrial structure. The four firms—General ...